The 60 Percent Solution

The Associated Press says that "big depositors at Cyprus' largest bank may be forced to accept losses of up to 60 percent". It added that "the remaining 40 percent of big deposits at the Bank of Cyprus will be "temporarily frozen for liquidity reasons."

The raid on depositors was the latest curtailment on  taxpayer bailouts for failing banks in the Eurozone. Eurogroup head Jeroen Dijsselbloem shocked the press 5 days ago when he said it was time to begin "pushing back the risks" onto the stakeholders of the bank, including the depositors. Dijsselbloem said:

If there is a risk in a bank, our first question should be 'Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself?'.

If the bank can't do it, then we'll talk to the shareholders and the bondholders, we'll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders.

Martin Sibeleu argues that Dijsselbloem ommitted the critical question of the order in which the stakeholders would be allowed to drown.  Like the sinking Titanic, it appeared to be First Class into the lifeboats. Steerage could follow as best it could.  Sibeleu maintains that  subordinated debtors were allowed to get out from under the suction first leaving unsecured depositors to go down with the ship.

In December of 2011 and February 2012, the European Central Bank (ECB) extended longer-term refinancing operations to provide liquidity to euro zone banks. The liquidity, in euros and at a below market price, was against sovereign debt held by the banks, as collateral. Part of this liquidity was used for what is called “liability management” exercises, where the banks changed the composition of their liabilities: They borrowed from the ECB to repay their subordinated debt holders. This is the reason why Cyprus should actually be a template for the rest of the Euro zone. Because across the Euro zone, subordinated debt was reduced, leaving unsecured depositors exposed….again, across the Euro zone.

If Cyprus were a template for the future, then the ticket you hold is important. The way Cyprus played out allows "unsecured depositors to be fair game across the Euro zone".  Sibeleu believes the previous bailouts were used to pay debtholders ahead of depositors.  "Euros loaned by the ECB, banks bought out subordinated investors ... In other words, both banks and subordinated debt holders enjoyed great capital gains, leaving unsecured depositors exposed to higher risk".

Glug. Glug. Glug.

Just how far the EU has fallen in less than a year was indicated by a Financial Times article of July 16, 2012. The article discussed Mario Draghi's then-jolting proposal to let senior bondholders share in the losses.  In those long-ago halcyon days only a few months ago Europe shuddered at the mere thought of letting senior bondholders take the hit to permitting depositors to bite the bullet.

The European Central Bank, in a sharp turnaround, advocated imposing losses on holders of senior bonds issued by the most severely damaged Spanish savings banks—though finance ministers have for now rejected the approach, according to people familiar with discussions.

The ECB’s new position was made clear by its president, Mario Draghi, at a meeting of euro-zone finance ministers discussing a rescue for Spain’s struggling local lenders in Brussels the evening of July 9…

In the July 9 meeting, Mr. Draghi argued in favor of including senior bank creditors in burden-sharing between taxpayers and investors in the case of Spain, three people familiar with the discussions said. Two said Mr. Draghi favored forcing losses on senior bondholders only when a bank was pushed into liquidation.

But that was then. This is now. And everyone is nervously eyeing the lifeboats because they know that when the Great Ship goes down proximity matters. A Greek newspaper is reporting scandalous stories of Cypriot politicians and insiders getting paid first. This list of those who jumped the line to get theirs makes interesting reading. Ideology seemingly went by the board as Communists fought with the best of them for their advance share of the money.

According to Ethnos, Bank of Cyprus wrote off the 2.8-million-euro loan of a hotel with ties to the communist-rooted Progressive Party (AKEL) and forgave significant portions of many other loans. For instance a national labor union is said to have been forgiven 193,000 euros of a 554,000-euro loan. An unnamed company was forgiven 110,000 euros from a 1.83-million-euro loan, a prominent deputy of the centrist Democratic Rally (DISY) party saw 101,000 euros of a 168,000-euro loan written off and a company owned by the brother of a former minister of the conservative Democratic Party (DIKO) had 1.28 million euros of a 1.59-million-euro loan written off.

The list refers to several other MPs and the mayor of large city who allegedly had significant portions of their loans forgiven by Bank of Cyprus. Companies linked to a member of the bank's board, to the daughter-in-law of a DIKO deputy and several others also appear to have been offered significant loan relief by the Bank of Cyprus.

As for Laiki Bank, it is said to have written off several loans taken out by MPs of AKEL and DISY. The bank also appears to have written off 5.8 million US dollars in debt from a company whose majority shareholder is said to be a well-known Cypriot politician. The ex wife of a senior ministry official and a company owned by a local ambassador also appear to have been facilitated.

Imagine that! Communists and unions grubbing for their money. And politicians too. Weren't they supposed to be dedicated to equality, justice and public service? It makes one wonder how fairly the pain will be shared if the Euro crisis deepens and another bank collapse occurs.

This brings to mind an old joke. Two explorers come upon an T-Rex on a mysterious island who lunges at them. The first says, "I'm glad I wore my running shoes." The second says, "you can't outrun the T-Rex." The first says, "I don't have to outrun the T-Rex, I just have to outrun you."

The Three Conjectures at Amazon Kindle for $1.99

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